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Read up before jumping on Google IPO

By Matt Krantz, USA TODAY

So you want to be a Google-aire? Join the crowd.

Even before the hugely popular Internet search engine finally unveiled its initial public offering plans, throngs of investors were salivating. Adding to the furor, Google is letting the average Jane and Joe investor compete head-to-head for shares with giant mutual funds like Fidelity and Vanguard. (Explainer: A walk through Google's S-1)

But along with an opportunity like this come huge risks and responsibilities. Competing with the big boys means you must do the same hard work and research they do. In this case — or that of any IPO, for that matter — that means poring over the IPO registration document. This document, usually referred to by its boring regulatory name, the S-1, is sometimes called by its slang name, a Red Herring.

Whatever you want to call it, the S-1 is essential reading for anyone who wants to brave the IPO market. Because companies are banned from hyping their IPOs, about the only information they can provide is in the S-1. That's why it's incredibly important you know how to read these often cumbersome documents before calling your broker.

Anyone can download an S-1 for free from the Securities and Exchange Commission's Web site at www.sec.gov. But keep in mind that you'll need to keep checking for updated versions. Companies will often file amended S-1 forms that fill in information not known when they first filed to go public.

To help you, USA TODAY checked with money managers and venture capitalists who were reading S-1s long before Google was a verb. Here are some of the red flags they look for when digging into an S-1:

•Inconsistent results. S-1s can be hundreds of pages, so it's easy to get overwhelmed. That's why Eric Hjerpe, partner at venture capital firm Atlas Venture, suggests heading straight for the financial statements embedded in the S-1.

You'll find the usual tables, including the income statement, balance sheet and sometimes a cash flow statement. Look immediately at the net income line. If you invest only in profitable firms, this is where you can quickly find out if the company loses money and avoid wasting any more time.

Even those familiar with regulatory filings need to view an S-1 differently, Hjerpe says. Look for patterns that prove growth can be maintained. For instance, he prefers companies that sell subscriptions or have long-term contracts with customers, so they don't need to start from scratch every quarter.

Consider Callidus Software. The company, which went public Nov. 20, 2003, had been profitable all year after posting losses during at least the previous five years. But its S-1 revealed the company's reliance on striking up business from new customers, and it pointed out that results could be volatile.

Just four months later, Callidus stunned investors with news that it would lose money in the first quarter due to weak sales. The stock is down 60% from its IPO.

Francis Gaskins, editor of IPOdesktop, suggests investors write down how much revenue and earnings the company has posted in each of the past five years, then multiply the most recent quarter's number by four. You want to see a steady, increasing trend.

This can help you identify — and avoid — companies that are running out of gas and trying to go public before things slow down.

•Onerous risks. One of the best things about an S-1 is that companies going public must state risks they face. The tough part, though, is that they usually go overboard and list any possible threats short of nuclear war.

So savvy investors need to separate the true risks from those companies throw in the S-1 to cover themselves for worst-case scenarios, says Kathy Smith, analyst at Renaissance Capital.

For instance, in Planet Hollywood's S-1 in 1996, the restaurant warned, "The Company's revenues will likely not continue to grow at the same rate in the future as they have in the past."

That warning underscored Smith's fear that tourists would eat at the themed restaurants once and never return. The company filed for bankruptcy-court protection just three years later. What sank it? Not enough repeat diners.

•Troubling lawsuits. When a company goes public, it must disclose any potentially harmful lawsuits it faces. These can be important contingencies to consider, says Paul Cook, portfolio manager of the Munder Net Net fund.

Sometimes the lawsuits reveal long-standing bad blood between the company and third parties. For instance, online trading market Archipelago's current S-1 cites a pending lawsuit that dates to 1999.

•Insiders bailing out. When a company raises money from the public, investors hope the cash will be plowed into profitable ventures that allow it to grow. But that's not always the case. Sometimes, companies use the IPO to cash out some of their early investors and even some current executives.

While allowing executives to cash out is a legitimate use of an IPO, investors need to be aware how their cash is being used.

Consider Intersections, which provide identity-theft protection services. While the company sold 6.3 million shares last month, it got to keep only about $51 million of the $100 million it raised. The rest went to former parent Equifax, which sold 87% of its holdings.

•Ridiculous valuation. This is more art than science. What's expensive to one investor is a screaming bargain to another. Still, there are benchmarks to consider.

Gaskins points to Webvan, the online grocery store that went public in the halcyon days of 1999. The company had revenue of only $395,000 the six months ended June 1999. That translates into just $790,000 for the year. Even so, the S-1 indicated Webvan would go public valued at $4.5 billion. "That was the bubble," he says.

Does all this seem like too much work? Wouldn't it be easier to forget the S-1 and just buy the IPO? Maybe, but that could be hazardous to your portfolio. Cook admits that S-1s are long and take hours to read. But by not reading it, he says, "You might end up with shares you don't want," he says.